QUESTION 1
An analyst has been asked to calculate and explain certain cash flow figures and definitions that relate to a company in their client’s portfolio.
Statement of financial position as of 31 December
An analyst has been asked to calculate and explain certain cash flow figures and definitions that relate to a company in their client’s portfolio.
Statement of financial position as of 31 December
Requirements:
A. Prepare the statement of cash flows using the indirect method. (15 marks)
B. Explain what is meant by free cash flow to the firm and free cash flow to the equity, calculate these for the company in exhibit 1 and comment. (5 marks)
C. What is meant by financial reporting quality, and earnings quality. An investor asks you to explain what is meant by conservative and aggressive accounting. Give 2 relevant examples of each. (6 marks)
D. The company had acquired an asset within PPE with a historical cost of £120,000. The value at each of the next four reporting periods are as follows:
80,000 110,000 130,000 140,000
At the end of the fourth period, the asset is sold for 140,000. There is accumulated depreciation on the machine of 20,000 at the first period end. Show the effects on the financial statements over the four reporting periods using the revaluation model. (4 marks)
E. Describe the effects that this choice of accounting treatment will have on the relevant accounts and financial ratios versus the historical cost approach if assets are increasing in value. (5 marks)
QUESTION 2
An intern is looking into some topical accounting issues and needs to investigate the following exhibits:
Exhibit 1
1. A company issue a 3year zero company bond with a PAR value of £5m. The company raises £4,711,612.
2. The analyst is looking at another company that has a bond with a face value and carrying amount of €10m with 3 years to maturity. The company chooses to redeem the bond early at a call price of 102.
Exhibit 2
The company has
1 January 5000,000 shares in issue
1 March 80,000 new shares issued
1 Sept 10% stock dividend
The company has in issue 100,000 preferred shares with a face value of £100 each, and a fixed dividend of 9%.
The company’s net income is £4,800,000
10,000 convertible bonds of 1000 PAR each, with a coupon of 5%.
Each bond converts to 12 shares in the company per 1,000 PAR.
Tax rate of the company is 30%.
The company is also considering a share buy back.
Requirements:
The following requirements relate to Exhibit 1:
A. With regards to exhibit 1 calculate the market interest rate implied in the bond value (round to the whole number). Demonstrate how this bond would be accounted for over it’s 3-year life using the effective interest method and straight line method. (6 marks)
B. With regards to part (2) of exhibit 1, show how this transaction would be recorded in the accounts, and what circumstances might lead the company to repay debt early. What changes should an analyst make to their indirect method cash flow operations calculation for this factor? (5 marks)
C. A company has capitalised interest in relation to financing costs incurred in the construction of an asset for its own use. Describe adjustments that an analyst will make when interpreting cash flows and coverage ratios. (3 marks)
The following requirements relate to Exhibit 2:
D. Calculate basic and diluted EPS based on the scenario. If the company had not issued those convertible bonds but instead the existing preferred shares were convertible into 0.7 ordinary shares per £100 PAR calculate the diluted EPS in this situation. (8 marks)
E. Explain the accounting treatment and rationale for a company share buy back including any relevant analysis. (8 marks)
QUESTION 3
Consider the following situations in the accounts:
Situation 1
In the notes:
1. An asset cost €110,000 and has a useful life of 3 years. The asset’s salvage value is estimated to be €25,000.
2. The following information relates to a long lived asset within PPE (the figures are in £’s).
The asset has projected cash flows of 1,095,000 per year end and is expected to last for 5 years.
The company WACC is 9% but the cash flows on this asset are more risky and require a 2% premium.
As a result of a severe economic slowdown the company believes an impairment test should be carried out.
The company reports under IFRS.
The firm is also considering using the revaluation model for some assets.
Situation 2
A company produced 120,000 finished goods and scrapped 3,000 in its current reporting period. The figures are in USD.
The costs for the finished goods were as follows:
The company spent 500,000 on inward freight charges and 300,000 on storage of finished goods.
The company currently uses the weighted average cost for inventory but is thinking about moving to FIFO.
Requirements:
The following requirements relate to Situation 1:
A. Calculate the depreciation expense in each of the 3 years if the company uses straight line depreciation. Calculate the expense if the company had used double declining balance. (5 marks)
B. Explain with 4 relevant ratios the effect of choosing accelerated depreciation, shorter lives and lower residual values, compared to a more conservative approach. (5 marks)
C. Define recoverable amount and determine if the asset needs to be impaired and the effect of any such impairment. How would the company recognise and treat any reversal of such an impairment. (5 marks)
The following requirements relate to Situation 2:
D. Calculate the total inventory cost and the per unit inventory cost and relevant period expense.(3 marks)
E. The inventory remains on the balance sheet at the year end. Explain how inventory is valued at each reporting date and how a decline in value would be adjusted for. (3 marks)
F. With regards to the potential decision to change the cost flow method, explain the effect on the relevant financial accounts using relevant rations if inventory costs were rising. (4 marks)
G. A different company uses LIFO as it’s cost flow method for inventory. Explain what is meant by the LIFO approach, the effect of this choice on relevant ratios and what is meant by the implication of LIFO liquidation. (5 marks)
Comments